FEAR AND GREED INDEX

As most savvy investors and traders know, fear and greed are the two emotions that cause the stock market to fall or rise respectively.  Smart investors and traders recognize this fact, and do not let their own emotions control their actions, and attempt to gain an edge in their investing and trading when others are swayed by extreme emotions.

More often than not, it is not the bad news that causes the share price of a stock (or stock market) to fall, but the perception of the effects of the bad news on the future of the company and the effects on company’s earnings. People are emotional beings, and tend to overreact routinely; knowing investor sentiment can help one make money in the stock market.

CNNMoney’s FEAR & GREED INDEX makes deciphering investor fear and greed easy by plotting it as an index on a 0 to 100 scale. The index is a composite of 7 indicators that track stock price momentum, stock price strength, stock price breadth, put and call options, junk bond demand, market volatility, and safe haven demand. See table for recent values and their FEAR & GREED INDEX page more information.

CNNMoney’s Fear & Greed Index

How to take advantage of extreme FEAR and GREED

Savvy investors and traders know how to make money when FEAR and GREED are at extremes – here’s how:

1. Fundamental Investors:

Smart ‘fundamental’ investors look for stocks with good fundamentals that may be selling at ‘bargain’ prices during irrational stock market downturns – since they know that when the stock market recovers, stocks with good fundamentals will be sought out by institutional buyers and will rise again.

2. Technical Traders:

Savvy technical traders do not care whether the market is rising or falling, but, by using a system based on a variety of technical indicators, such as MACD, stochastics, RSI, etc., they ride the market up and then short the market on its way down.

3. Stock Option Traders:

Experienced options traders love volatile markets and extreme of FEAR and GREED, as such situations translate in to more money-making opportunities. One that I favor is playing a rebound after a sharp market downturn.  After a large and/or sudden market downturn, FEAR is rampant, and the implied volatility (IV) in option chains rises dramatically. By using option strategies that benefit by the collapse of IV as the stock market rises, on can generate a quick profit very quickly.  Some of my favorites are a bull put spread, an OTM call butterfly, ITM put broken-wing butterfly or ITM put modifly.

Additionally, the knowledgeable options trader knows how to structure his/her trade to benefit from theta decay while waiting for the up move to occur – thus, capitalizing on the benefit of the move up, the collapse of IV and theta decay – a win-win-win strategy if there ever was one.

Happy Trading!